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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
ÈANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
‘TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 1-12718
HEALTH NET, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 95-4288333
(State or Other Jurisdiction
of Incorporation or Organization)
(I.R.S. Employer
Identification No.)
21650 Oxnard Street, Woodland Hills, CA 91367
(Address of Principal Executive Offices) (Zip Code)
Registrant’s Telephone Number, Including Area Code: (818) 676-6000
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock, $.001 par value New York Stock Exchange, Inc.
Rights to Purchase Series A Junior Participating
Preferred Stock
New York Stock Exchange, Inc.
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes ÈNo ‘
Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes ‘No È
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ÈNo ‘
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. È
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act (check one).
Large accelerated filer ÈAccelerated filer ‘Non-accelerated filer ‘
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes ‘No È
The aggregate market value of the voting stock held by non-affiliates of the registrant at June 30, 2006 was
$5,187,937,157 (which represents 114,853,601 shares of Common Stock held by such non-affiliates multiplied by $45.17, the
closing sales price of such stock on the New York Stock Exchange on June 30, 2006).
The number of shares outstanding of the registrant’s Common Stock as of January 31, 2007 was 111,911,622 (excluding
28,816,339 shares held as treasury stock).
Documents Incorporated By Reference
Part III of this Form 10-K incorporates by reference certain information from the registrant’s definitive proxy statement
for the 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after
the close of the year ended December 31, 2006.

Table of contents

  • Page 1
    ...Charter) HEALTH NET, INC. Delaware (State or Other Jurisdiction of Incorporation or Organization) 95-4288333 (I.R.S. Employer Identification No.) 21650 Oxnard Street, Woodland Hills, CA (Address of Principal Executive Offices) 91367 (Zip Code) Registrant's Telephone Number, Including Area Code...

  • Page 2
    HEALTH NET, INC. INDEX TO FORM 10-K Page PART I. Item 1-Business ...General ...Segment Information ...Provider Relationships ...Additional Information Concerning Our Business ...Government Regulation ...Intellectual Property ...Employees ...Dependence Upon Customers ...Recent and Other Developments...

  • Page 3
    ... drugs and offer managed health care product coordination for multi-region employers and administrative services for medical groups and self-funded benefits programs. In addition, we own health and life insurance companies licensed to sell exclusive provider organization ("EPO"), PPO, POS...

  • Page 4
    ... to employer groups and individual insureds. As of December 31, 2006, 42% of our commercial members were covered by POS and PPO products, 55% were covered by conventional HMO products and 3% were covered by EPO and fee-for-service products, including new health plans such as consumer-directed health...

  • Page 5
    ...Your Life WellsiteSM, which provides commercial and Medicare members easy access to information they need to make smarter choices about their health, health care and health care costs. Consumer Directed Health Plan products such as Health Savings Accounts and Health Reimbursement Accounts. Community...

  • Page 6
    ... any Medicaid members in Oregon as of December 31, 2006. Northeast. Our Northeast operations are conducted in Connecticut, New Jersey and New York. For our large employer group business, we directly market commercial HMO, PPO and POS products in Connecticut and New York; an EPO product in New York...

  • Page 7
    ... any Medicaid members in New York as of December 31, 2006. Medicare Products We offer our Medicare products directly to individuals and through employer groups. To enroll in one of our Medicare plans, covered persons must be eligible for Medicare. We provide or arrange health care services normally...

  • Page 8
    ... contract with DSS to be effective July 1, 2007. In New Jersey, we participate in the New Jersey Medicaid program, as well as the New Jersey SCHIP program, which is known as New Jersey FamilyCare. These programs provide comprehensive health care coverage for children and families as well as members...

  • Page 9
    ...,000 Medicare members. HNPS manages these benefits in an effort to achieve the lowest cost for its customers. HNPS contracts with national health care providers, vendors, drug manufacturers and pharmacy distribution networks, oversees pharmacy claims and administration, reviews and evaluates new FDA...

  • Page 10
    ... products focusing on wellness and behavioral change programs were introduced and are available as part of MHN's commercial EAP solutions. In addition, MHN provided its workplace and work-life services to members of Health Net affiliated medical plans, including Medicare members. MHN's EAP services...

  • Page 11
    ... care claim run under the North Region contract based on paid claims with an annual reconciliation of the risk sharing provision. We are not responsible for providing most pharmaceutical benefits, claims processing for TRICARE and Medicare dual eligibles and certain marketing and education services...

  • Page 12
    ...from the services provided under our TRICARE contract for the North Region. Total revenue for these subcontracts for the year ended December 31, 2006 was $53.4 million. Veterans Affairs During 2006, HNFS administered 14 contracts with the U.S. Department of Veterans Affairs to manage community-based...

  • Page 13
    .... Outside of California, most of our HMOs reimburse physicians according to a discounted fee-for-service schedule, although several have capitation arrangements with certain providers and provider groups in their market areas. For services provided under our PPO products and the out-of-network...

  • Page 14
    ...their service areas. These hospital contracts generally have multi-year terms or annual terms with automatic renewals and provide for payments on a variety of bases, including capitation, per diem rates, case rates and discounted fee-for-service schedules. Covered inpatient hospital care for our HMO...

  • Page 15
    ... small, regional-based health plans that compete with Health Net in California, mainly in the small business group market segment. In addition, two of the major national managed care companies, Aetna, Inc. and CIGNA Corp., are active in California. Their respective commercial full-risk market share...

  • Page 16
    ...Company's website. The new Wellsite gives commercial and Medicare members easy access to information they need to make smarter choices about their health and about their health care and health care costs. As more employers begin to offer consumer directed health plans such as Health Savings Accounts...

  • Page 17
    ...the new authorization and reporting medical management system in 2006. As a result, the conversion of the California and Oregon claim components of Health Net One was rescheduled for 2007/2008. This strategy permits continued focus on delivering capabilities to meet market demands, increase revenues...

  • Page 18
    ... adjustment factor reflects the member's age, gender and health status. The MMA also authorized regional PPOs to serve 26 regions covering the U.S. and its territories, and authorized other products designed to provide a private market option on a broader scale. Our Medicare contracts are subject to...

  • Page 19
    ...govern our health plans and insurance companies. Company Arizona HMO California HMO Connecticut HMO New Jersey HMO New York HMO Oregon HMO Health Net Life Insurance Company Health Net Insurance Company of New York MHN Regulatory Agency Arizona Department of Insurance California Department of Managed...

  • Page 20
    ... benefits and required offerings of benefits that are optional coverages; Procedures for member grievance resolution and medical necessity determinations; Accessibility of providers, handling of provider claims (including out-of-network claims) and adherence to timely and accurate payment and appeal...

  • Page 21
    ... persons on a part-time or temporary basis. These employees perform a variety of functions, including, among other things, provision of administrative services for employers, providers and members; negotiation of agreements with physician groups, hospitals, pharmacies and other health care providers...

  • Page 22
    ... price of such Right, that number of shares of common stock having a market value of two times such exercise price. In addition, and subject to certain exceptions contained in the Rights Agreement, in the event that we are acquired in a merger or other business combination in which the common stock...

  • Page 23
    ...'s managed care book of business in its various product lines. As of December 31, 2006, we retained 27,655 Medi-Cal and Healthy Families beneficiaries, 6,454 Medicare Advantage beneficiaries and 48,950 commercial members. See Note 3 to the consolidated financial statements for additional information...

  • Page 24
    ... health care costs has been the cost of hospital-based products and services. Factors underlying the increase in hospital costs include, but are not limited to, the underfunding of public programs, such as Medicaid and Medicare, growing rates of uninsured individuals, new technology, state initiated...

  • Page 25
    ... are generally intended to benefit and protect providers and health plan members rather than stockholders of managed health care companies such as Health Net. The laws and rules governing our business and interpretations of those laws and rules are subject to frequent change. Broad latitude is given...

  • Page 26
    ...information and increased pharmaceutical costs, (as well as the underlying seasonality of this business). In addition, in connection with our participation in the Medicare Advantage and Part D programs, we regularly record revenues associated with the risk adjustment reimbursement mechanism employed...

  • Page 27
    ...of the regional concentration of our business. Our business operations are concentrated in the Northeast (in the states of Connecticut, New York and New Jersey) and in the states of California, Arizona and Oregon. Our California operations represented approximately 45.5% of our total revenue in 2006...

  • Page 28
    ... small group markets, placing a cap on loss ratios or premiums or otherwise taking steps to expand access to health insurance in a manner that does not allow for management of risk. The decisions of health plans to rescind coverage and decline payment to treating providers has also generated public...

  • Page 29
    .... We contract with physicians, hospitals and other providers as a means to assure access to health care services for our members, to manage health care costs and utilization and to better monitor the quality of care being delivered. In any particular market, providers could refuse to contract with...

  • Page 30
    ...-renewal of coverage and insufficient payments for out-ofnetwork services; claims by employer groups for return of premiums; and claims by providers, including claims for withheld or otherwise insufficient compensation or reimbursement, claims related to self-funded business, and claims related to...

  • Page 31
    ..., during 2006, gross margins in our commercial and Medicare lines of business were better than expected, pretax margins in our Government Contracts segment were higher than projected and administrative expenses were higher than expected. In prior years, commercial and Medicare health care costs have...

  • Page 32
    ... major managed care organization has launched, announced or is developing HSA-compatible high-deductible health plans. We have launched HSA programs in our Northeast, Arizona, California and Oregon health plans. Our HSA programs represented a very small percentage of our total revenue in 2006. Some...

  • Page 33
    ... pay our debt depends, in part, on the amount of cash that we receive from our subsidiaries. Our subsidiaries' ability to make any payments to us will depend on their earnings, business and tax considerations, legal and regulatory restrictions and economic conditions. In addition, in certain states...

  • Page 34
    ..., pricing our services, monitoring utilization and other cost factors, processing provider claims, billing our customers on a timely basis and identifying accounts for collection. Our customers and providers also depend upon our information systems for membership verification, claims status and...

  • Page 35
    ...Connecticut Medicaid business. In 2006, a petition was submitted to the Connecticut Freedom of Information Commission (the "CT FOIC") seeking, among other things, information regarding provider reimbursement rates and maintenance of preferred drug lists used by managed care organizations contracting...

  • Page 36
    ...including public communications regarding managed care, legislative or regulatory actions, litigation or threatened litigation, health care cost trends, pricing trends, competition, earnings or membership reports of particular industry participants, and market speculation about or actual acquisition...

  • Page 37
    ... actions and the responsiveness of public health agencies and insurance companies, a large-scale public health epidemic or future acts of bio-terrorism could lead to, among other things, increased use of health care services, disruption of information and payment systems, increased health care costs...

  • Page 38
    ... Health Net, Inc., Health Net of the Northeast, Inc. and Health Net of New Jersey, Inc. violated ERISA in connection with various practices related to the reimbursement of claims for services provided by out-of-network providers. Plaintiffs seek relief in the form of payment of benefits, injunctive...

  • Page 39
    ... its expense to oversee the completion of discovery in these cases; ordering that a monetary sanction be imposed upon Health Net once the District Court reviews Health Net's financial records; ordering Health Net to pay plaintiffs' counsel's fees and expenses associated with the sanctions motion and...

  • Page 40
    ...,000 physicians and state and other medical societies announced that we had signed an agreement settling the lead physician provider track action. The settlement agreement requires us to pay $40 million to general settlement funds and $20 million for plaintiffs' legal fees. During the three months...

  • Page 41
    ..." of AmCareco following the sale of the plans for post-acquisition misconduct by AmCareco and others that caused the three health plans to fail and ultimately be placed into receivership. The action brought against us by the receiver for AmCare-LA action originally was filed in Louisiana on June 30...

  • Page 42
    ... to the United States District Court for the Central District of California. The lawsuit ("Superior Lawsuit") related to the 1998 sale by FHC to Superior of the stock of Business Insurance Group, Inc. ("BIG"), a holding company of workers' compensation insurance companies operating primarily in...

  • Page 43
    ... number of the provider disputes that were included as part of the $169 million earnings charge that we recorded in the fourth quarter of 2004. See Note 12 to our consolidated financial statements for additional information. On October 6, 2006 we entered into a Consent Agreement with the California...

  • Page 44
    ...cash flow for such period. However, at this time, management believes that the ultimate outcome of all of these other legal proceedings that are pending, after consideration of applicable reserves and potentially available insurance coverage benefits, should not have a material adverse effect on our...

  • Page 45
    ... regulatory net worth requirements and additional state regulations which may restrict the declaration of dividends by HMOs, insurance companies and licensed managed health care plans. The payment of any dividend is at the discretion of our Board of Directors and depends upon our earnings, financial...

  • Page 46
    ... tax benefits the Company had received from the exercise of employee stock options). We may repurchase shares of our common stock under the stock repurchase program from time to time in open market transactions, privately negotiated transactions, or through accelerated share repurchase programs, or...

  • Page 47
    ... of December 31, 2006, we did not terminate prior to expiration any repurchase program. Under the Company's various stock option and long-term incentive plans, employees and non-employee directors may elect for the Company to withhold shares to satisfy minimum statutory federal, state and local tax...

  • Page 48
    ...Annual Report on Form 10-K. Year Ended December 31, 2006(12) 2005 2004 2003 2002 (Dollars in thousands, except per share and PMPM data) REVENUES: Health plan services premiums (1) ...Government contracts ...Net investment income ...Administrative services fees and other income (1) ...Total revenues...

  • Page 49
    ...) The selling costs ratio is computed as selling expenses divided by health plan services premium revenues. (11) PMPM is calculated based on total at-risk member months and excludes ASO member months. (12) On January 1, 2006, we began offering the new Medicare Part D prescription drug benefits. 47

  • Page 50
    ... drugs, and offer managed health care product coordination for multi-region employers and administrative services for medical groups and self-funded benefits programs. How We Report Our Results We currently operate within two reportable segments, Health Plan Services and Government Contracts...

  • Page 51
    Health plan services premiums include HMO, POS and PPO premiums from employer groups and individuals and from Medicare recipients who have purchased supplemental benefit coverage (which premiums are based on a predetermined prepaid fee), Medicaid revenues based on multi-year contracts to provide ...

  • Page 52
    ... to large employer groups in California, Connecticut, New Jersey and New York. Under these arrangements, we provide claims processing, customer services, medical management, provider network access and other administrative services. Effective in 2006, we reported revenues from our ASO business in...

  • Page 53
    ... fiscal years: Year Ended December 31, 2006 2005 2004 (Dollars in thousands, except per share and PMPM data) Revenues Health plan services premiums ...Government contracts ...Net investment income ...Administrative services fees and other income ...Total revenues ...Expenses Health plan services...

  • Page 54
    ... Advantage Private-Fee-For Service plans, and we began marketing our Medicare Part D plans in all 50 states and the District of Columbia. We also increased the number of Part D plan choices that we offer seniors from two in 2006 to three in 2007, one of which provides beneficiaries with coverage...

  • Page 55
    ... to the May 2005 settlement agreement to resolve the lead physician provider track action in the multidistrict class action lawsuit, and $15.9 million of estimated legal defense costs to appeal a Louisiana state court jury verdict related to the 1999 sale of three health plan subsidiaries. See "Item...

  • Page 56
    ... reportable segments for the last three fiscal years: Year Ended December 31, 2006 2005 2004 (Dollars in millions) Pretax income: Health plan services segment ...Government contracts segment ...Total segment pretax income ...Debt refinancing charge ...Litigation, severance and related benefit costs...

  • Page 57
    ... to address higher health care costs and network provider issues. The enrollment decline was primarily seen in our California plan which had a net decline of 17,874 members in the large group market and a net decline of 85,867 members in the PPO/POS products for the small group and individual market...

  • Page 58
    ...for the members participating in the new Medicare Part D prescription drug program effective January 1, 2006 and favorable Medicare risk factor adjustments in our Arizona, California, Connecticut, Oregon and New York plans totaling $92.0 million in the year ended December 31, 2006 (see "-Health Plan...

  • Page 59
    ... premium PMPM was 3% for the year ended December 31, 2005 over the same period in 2004, primarily due to rate increases for the Healthy Families and Access for Infants and Mothers (AIM) programs. These programs accounted for approximately 12% of total Medicaid membership. Health Plan Services Costs...

  • Page 60
    ... "-Health Plan Services Premiums" for detail regarding the increase in premium revenue related to the 2003 and 2004 Medicare rate adjustment). These increases were partially offset by provider settlements of $14.6 million recorded in the fourth quarter of 2004. Medicaid health care costs increased...

  • Page 61
    ...Medicare expansion plans, an increase in marketing activities for new product development, the addition of the members from the Universal Care Acquisition, new business bid costs and recognition of stock option expense as a result of adopting SFAS No. 123(R). See Note 2 to our consolidated financial...

  • Page 62
    ... interest rate we paid on the swap contract settlements. Government Contracts Segment Membership 2005 2004 2006 (Membership in thousands) Membership under North Region TRICARE contract ... 2,930 2,962 2,929 Under our TRICARE contract for the North Region, we provide health care services to...

  • Page 63
    ...in Government Contracts revenues was primarily due to an increase in health care services provided under our TRICARE contract for the North Region resulting from a rise in demand for private sector services as a direct result of continued heightened military activity. Government Contracts Costs Year...

  • Page 64
    ...a lawsuit arising from the 1999 sale of three of our health plan subsidiaries to Amcareco, Inc. The aggregate amount of the judgments was $108.7 million. During the three months ended June 30, 2005, we recorded a pretax charge of $15.9 million representing total estimated legal defense costs related...

  • Page 65
    ... from our old TRICARE contracts to the TRICARE contract for the North Region. See Note 14 to our consolidated financial statements for further information on severance and related benefit costs, asset impairments and lease termination costs. Net Gain on Sales of Businesses and Properties 2004...

  • Page 66
    ... TRICARE contract for the North Region. Health care receivables related to TRICARE are best estimates of payments that are ultimately collectible or payable. The timing of collection of such receivables is impacted by government audit and negotiation and can extend for periods beyond a year. Amounts...

  • Page 67
    ... for physician class action settlement as discussed in "-Litigation, Severance and Related Benefit Costs and Asset Impairments" above, and Net increase of $53 million in amounts receivable, net of $72 million in payables, related to Medicare Part D business that began on January 1, 2006. Year Ended...

  • Page 68
    ... and tax benefits the Company had received to date from the exercise of employee stock options). The Board of Directors also increased the size of the stock repurchase program by $235 million. As a result, the Company was then authorized under the stock repurchase program to acquire shares of its...

  • Page 69
    ... $43 million provided by the sale of the Pledged Securities was used to cover $11.1 million in costs for the termination and settlement of our Swap Contracts and to pay approximately $3 million of professional fees and other expenses related to the refinancing of the Senior Notes. The remaining...

  • Page 70
    ... to manage certain exposures related to the effect of changes in interest rates on our Senior Notes. See "Quantitative and Qualitative Disclosures About Market Risk" and Note 6 to our consolidated financial statements for additional information regarding the Swap Contracts. We incurred a total of...

  • Page 71
    ... (plus proceeds received by us from the exercise of stock options held by employees, management or directors of the company and any tax benefit to us related to such exercise) in any consecutive four-quarter period, less other restricted payments made in such period, except that we may repurchase...

  • Page 72
    ... by state and are generally based on balances established by statute, a percentage of annualized premium revenue, a percentage of annualized health care costs, or risk-based capital (RBC) requirements. The RBC requirements are based on guidelines established by the National Association of Insurance...

  • Page 73
    ... is granted, limit the use of any cash generated by these subsidiaries to pay our obligations. The maximum amount of dividends that can be paid by our insurance company subsidiaries without prior approval of the applicable state insurance departments is subject to restrictions relating to statutory...

  • Page 74
    ... advice line and other related services, a five-year agreement for a disease and condition management services and a four-year Medicare Part D pharmacy claims processing services agreement, and a three-year agreement for outsourcing services for our Prescription Drug Plan and Private Fee for Service...

  • Page 75
    ...Health Plan Services Health plan services premiums include HMO, POS and PPO premiums from employer groups and individuals and from Medicare recipients who have purchased supplemental benefit coverage (for which premiums are based on a predetermined prepaid fee), Medicaid revenues based on multi-year...

  • Page 76
    ... in the California commercial market. Shared-risk arrangements provide for us to share with our providers the variance between actual costs and predetermined goals. Our health plans in Connecticut, New Jersey and New York market to small employer groups through a joint venture agreement with The...

  • Page 77
    ... as medical management, claims processing, enrollment, customer services and other services unique to the managed care support contracts with the government. Health care costs and associated revenues are recognized as the costs are incurred and the associated revenue is earned. Revenue related to...

  • Page 78
    ... disputes with members, health care providers, and other entities, as well as audits by government agencies that relate to our services and/or business practices that expose us to potential losses. We recognize an estimated loss, which may represent damages, settlement costs, future legal expenses...

  • Page 79
    ... enacted tax rates and laws to taxable years in which such differences are expected to reverse. We establish a valuation allowance in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." We continually review the adequacy...

  • Page 80
    ... in accounting principle in the financial statements for the three months ended March 31, 2007. We anticipate the impact to be an immaterial reduction to the beginning balance of retained earnings. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. We are exposed to interest rate...

  • Page 81
    ... estimated, based upon actual fluctuations in market rates, operating exposures, and the timing thereof, and changes in our investment portfolios during the year. We had used interest rate swap contracts as a part of our hedging strategy to manage certain exposures related to the effect of changes...

  • Page 82
    ... Report of Independent Registered Public Accounting Firm are incorporated in this Item 8 by reference and filed as part of this Annual Report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not applicable. Item 9A. Controls and Procedures...

  • Page 83
    ... as of December 31, 2006. Management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which is included herein. Because...

  • Page 84
    ...OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Health Net, Inc. Woodland Hills, California We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that Health Net, Inc. and...

  • Page 85
    ..., in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2006 of the Company and our report dated February 28, 2007 expressed an unqualified...

  • Page 86
    ... filed with the SEC within 120 days of December 31, 2006, under the captions "Health Net, Inc. Compensation Discussion & Analysis," "Executive Compensation," "Directors' Compensation," "Compensation Committee Interlocks and Insider Participants" and "Compensation Committee Report." Such information...

  • Page 87
    ...Trust National Association, as trustee (filed as Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 (File No. 1-12718) and incorporated herein by reference). Amended and Restated Employment Agreement dated as of October 4, 2006 between Health Net, Inc. and...

  • Page 88
    ...'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 (File No. 1-12718) and incorporated herein by reference). Employment Agreement between James Woys and Health Net, Inc. dated January 30, 2006 (filed as Exhibit 10.8 to the Company's Annual Report of Form 10-K for the year...

  • Page 89
    ...). Amendment Number One to the Health Net, Inc. (formerly Foundation Health Systems, Inc.) Deferred Compensation Plan Trust Agreement between Health Net, Inc. and Union Bank of California, adopted January 1, 2001 (filed as Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year ended...

  • Page 90
    ... the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (File No. 1-12718) and incorporated herein by reference). Health Net, Inc. Management Incentive Plan adopted December 2004 (filed as Exhibit 10.40 to the Company's Annual Report on Form 10-K for the year ended December...

  • Page 91
    ...). Amendment Number Seven to the Health Net, Inc. 401(k) Savings Plan adopted December 27, 2006, a copy of which is filed herewith. Foundation Health Systems, Inc. Supplemental Executive Retirement Plan effective as of January 1, 1996 (filed as Exhibit 10.65 to the Company's Annual Report on Form 10...

  • Page 92
    ... Agent (filed as Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 (File No. 1-12718) and incorporated herein by reference). Security and Control Agreement, dated June 23, 2006, by and between Health Net, Inc., U.S. Bank Trust National Association...

  • Page 93
    ...of per share earnings of the Company (included in Note 2 to the consolidated financial statements included as part of this Annual Report on Form 10-K). Subsidiaries of Health Net, Inc., a copy of which is filed herewith. Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm...

  • Page 94
    ... behalf by the undersigned thereunto duly authorized. HEALTH NET, INC. By: /S/ JAMES E. WOYS James E. Woys Interim Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and...

  • Page 95
    ... schedules are filed as part of this Annual Report on Form 10-K: Consolidated Financial Statements Report of Independent Registered Public Accounting Firm ...Consolidated Statements of Operations for each of the three years in the period ended December 31, 2006 ...Consolidated Balance Sheets...

  • Page 96
    REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Health Net, Inc. Woodland Hills, California We have audited the accompanying consolidated balance sheets of Health Net, Inc. and subsidiaries (the "Company") as of December 31, 2006 and 2005, and ...

  • Page 97
    HEALTH NET, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands, except per share data) 2006 Year Ended December 31, 2005 2004 Revenues Health plan services premiums ...Government contracts ...Net investment income ...Administrative services fees and other income ...Total revenues ......

  • Page 98
    ...for claims and other settlements ...Health care and other costs payable under government contracts ...IBNR health care costs payable under TRICARE North contract ...Unearned premiums ...Bridge loan ...Accounts payable and other liabilities ...Total current liabilities ...Senior notes payable ...Term...

  • Page 99
    ... Stock Compensation Capital Shares Amount Balance as of January 1, 2004 ...133,421 Comprehensive income: Net income ...Minimum pension liability adjustment ...Change in unrealized appreciation on investments, net of tax benefit of $2,217 ...Total comprehensive income ...Exercise of stock options...

  • Page 100
    ...from exercise of stock options and employee stock purchases ...Excess tax benefit on share-based compensation ...Repurchases of common stock ...Proceeds from issuance of bridge and term loans ...Repayment of senior notes and debt refinancing costs ...Other ...Net cash (used in) provided by financing...

  • Page 101
    ...HMOs), insured preferred provider organizations (PPOs) and point of service (POS) plans to approximately 6.6 million individuals in 27 states and the District of Columbia through group, individual, Medicare (including the Medicare prescription drug benefit commonly referred to as "Part D"), Medicaid...

  • Page 102
    ... Health plan services premium revenues include HMO, POS and PPO premiums from employer groups and individuals and from Medicare recipients who have purchased supplemental benefit coverage, for which premiums are based on a predetermined prepaid fee, Medicaid revenues based on multi-year contracts...

  • Page 103
    ... certain hospitals to provide hospital care to enrolled members on a capitation basis. Our HMOs also contract with hospitals, physicians and other providers of health care, pursuant to discounted fee-for-service arrangements, hospital per diems, and case rates under which providers bill the HMOs for...

  • Page 104
    ... level in relation to the Federal Poverty Level. The low-income premium subsidy is recognized evenly over the contract period and reported as part of health plan services premium revenue. Low-Income Member Cost Sharing Subsidy-For qualifying low-income members, CMS will reimburse Health Net, on the...

  • Page 105
    ... our health plan services premium revenues. We also recognized $9.7 million and $0 for the years ended December 31, 2005 and 2004, respectively, of capitation expense related to the Medicare risk factor estimates from 2003 and 2004 in our health plan services costs. Share-Based Compensation Expense...

  • Page 106
    ... is estimated using a BlackScholes option-pricing model and amortized to expense over the options' vesting periods. 2005 2004 Net income, as reported ...Add: Stock- based employee compensation expense included in reported net income, net of related tax effects ...Deduct: Total pro forma stock-based...

  • Page 107
    HEALTH NET, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Investments Investments classified as available-for-sale are reported at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported as other comprehensive income, net of income...

  • Page 108
    ... been converting a number of information systems in our Health Plan business to a single information system. This project, known as Health Net One, also includes consolidation initiatives for other functional areas, such as claims handling, customer service and product development. Costs related to...

  • Page 109
    ...-line method over their estimated lives are as follows: Gross Carrying Amount Weighted Average Life (in years) Accumulated Net Amortization Balance (Dollars in millions) As of December 31, 2005: Provider networks ...Employer groups ...As of December 31, 2006: Provider networks ...Employer groups...

  • Page 110
    ... premiums receivable are limited due to the large number of payers comprising our customer base. Our 10 largest employer group premiums receivable balances within each of our plans accounted for 45% and 47% of our total premiums receivable as of December 31, 2006 and 2005, respectively. Our Medicare...

  • Page 111
    ..., the federal Government is a significant customer of the Company's Health Plan Services segment as a result of its contract with CMS for coverage of Medicare-eligible individuals. Medicare revenues accounted for 22% of our health plan premiums in 2006. Earnings Per Share Basic earnings per share...

  • Page 112
    ... 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115" (SFAS No. 159). SFAS No. 159 provides companies with an option to report selected financial assets and...

  • Page 113
    ...of our Health Plan Services reportable segment. The revenues and expenses of the Pennsylvania Subsidiaries were negligible for the years ended December 31, 2006, 2005 and 2004. Acquisition of Universal Care Business On March 31, 2006, we completed the acquisition of certain health plan businesses of...

  • Page 114
    ...and their revenues and expenses were negligible for the years ended December 31, 2005 and 2004. Prior Sales We recognized a net pretax gain totaling $1.2 million in the year ended December 31, 2004 related to the true-up of the 2001 sale of our Florida health plan, 2003 sale of our dental and vision...

  • Page 115
    HEALTH NET, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Note 4-Investments As of December 31, 2006 and 2005, the amortized cost, gross unrealized holding gains and losses, and fair value of our available-for-sale investments were as follows: 2006 Gross Gross Unrealized Unrealized ...

  • Page 116
    ... table shows the number of our individual securities that have been in a continuous loss position at December 31, 2006. Less than 12 Months 12 Months or More Total Mortgage-backed ...U.S. government and agencies ...Obligation of states and other political subdivisions ...Corporate debt ... 31 10...

  • Page 117
    ... $43 million provided by the sale of the Pledged Securities was used to cover $11.1 million in costs for the termination and settlement of our Swap Contracts and to pay approximately $3 million of professional fees and other expenses related to the refinancing of the Senior Notes. The remaining...

  • Page 118
    HEALTH NET, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) As a result of our pledge of the Pledged Securities to secure the Senior Notes under the Security and Control Agreement, Moody's and S&P upgraded their ratings on the Senior Notes to investment grade (Baa1 and BBB, respectively)...

  • Page 119
    ... million (plus proceeds received by us from the exercise of stock options held by employees, management or directors of the company and any tax benefit to us related to such exercise) in any consecutive four-quarter period, less other restricted payments made in such period, except that we would be...

  • Page 120
    ...received by us from the exercise of stock options held by employees, management or directors of the company and any tax benefit to us related to such exercise) less other restricted payments made in such period. Letters of Credit We can obtain letters of credit in an aggregate amount of $300 million...

  • Page 121
    ...of our full-time employees were eligible to participate. The stockholders have approved our various stock option and long-term incentive plans except for the 1998 Stock Option Plan, which was adopted by our Board of Directors. In May 2005, the stockholders approved the Health Net, Inc. 2005 LongTerm...

  • Page 122
    HEALTH NET, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) implied volatilities from traded options on our stock, historical volatility of our stock and other factors. We estimated the expected term of options by using historical data to estimate option exercise and employee termination...

  • Page 123
    HEALTH NET, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) We have entered into restricted stock and RSU agreements with certain employees. We have awarded shares of restricted common stock under the restricted stock agreements and rights to receive common stock under the RSU agreements...

  • Page 124
    HEALTH NET, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Under the Company's various stock option and long-term incentive plans, employees and non-employee directors may elect for the Company to withhold shares to satisfy minimum statutory federal, state and local tax withholding and ...

  • Page 125
    ... and tax benefits the Company had received to date from the exercise of employee stock options). The Board of Directors also increased the size of the stock repurchase program by $235 million. As a result, the Company was then authorized under the stock repurchase program to acquire shares of its...

  • Page 126
    ... tax benefits the Company had received from the exercise of employee stock options). We may repurchase shares of our common stock under the stock repurchase program from time to time in open market transactions, privately negotiated transactions, or through accelerated share repurchase programs, or...

  • Page 127
    ... participants. Under these plans, we pay a percentage of the costs of medical, dental and vision benefits during retirement. The plans include certain cost-sharing features such as deductibles, co-insurance and maximum annual benefit amounts that vary based principally on years of credited service...

  • Page 128
    ..., beginning of year ...Service cost ...Interest cost ...Benefits paid ...Actuarial loss (gain) ...Benefit obligation, end of year ...Change in fair value of plan assets: Plan assets, beginning of year ...Employer contribution ...Benefits paid ...Plan assets, end of year ...Underfunded status, end of...

  • Page 129
    ... 0.5 - - (0.1) - $ 0.7 $ 0.9 The estimated net (gain) loss and prior service cost for the defined benefit pension plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $0.1 million and $0.5 million, respectively. All of...

  • Page 130
    ...reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects for the year ended December 31, 2006: 1-Percentage 1-Percentage Point Point Increase Decrease (Dollars in millions) Effect on total of service and interest cost...

  • Page 131
    ... the federal and state net operating loss carryforwards, respectively. Accordingly, valuation allowances have been provided to account for the potential limitations on utilization of these tax benefits. Of the $21.2 million total valuation allowance, $13.1 million is related to the prior acquisition...

  • Page 132
    ...with statutory accounting and reporting practices. Under the Knox-Keene Health Care Service Plan Act of 1975, as amended, California plans must comply with certain minimum capital or tangible net equity requirements. Our non-California health plans, as well as our health and life insurance companies...

  • Page 133
    ... Health Net, Inc., Health Net of the Northeast, Inc. and Health Net of New Jersey, Inc. violated ERISA in connection with various practices related to the reimbursement of claims for services provided by out-of-network providers. Plaintiffs seek relief in the form of payment of benefits, injunctive...

  • Page 134
    ... its expense to oversee the completion of discovery in these cases; ordering that a monetary sanction be imposed upon Health Net once the District Court reviews Health Net's financial records; ordering Health Net to pay plaintiffs' counsel's fees and expenses associated with the sanctions motion and...

  • Page 135
    ...and state and other medical societies announced that we had signed an agreement settling the lead physician provider track action. The settlement agreement requires us to pay $40 million to general settlement funds and $20 million for plaintiffs' legal fees and to commit to several business practice...

  • Page 136
    HEALTH NET, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Lawsuits Relating to Sale of Businesses AmCareco Litigation We are a defendant in two related litigation matters pending in Louisiana and Texas state courts, both of which relate to claims asserted by three separate state ...

  • Page 137
    ... to the United States District Court for the Central District of California. The lawsuit (Superior Lawsuit) related to the 1998 sale by FHC to Superior of the stock of Business Insurance Group, Inc. (BIG), a holding company of workers' compensation insurance companies operating primarily in...

  • Page 138
    HEALTH NET, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) and/or concealed material facts relating to the sufficiency of the BIG companies' reserves and about the BIG companies' internal financial condition, including accounts receivables and the status of certain "captive" insurance ...

  • Page 139
    ...to the original estimated provider dispute liability amount. In connection with these settlements, we have entered into new contracts with a large portion of our provider network. On October 6, 2006 we entered into a Consent Agreement with the California Department of Managed Health Care (DMHC) with...

  • Page 140
    ... agreement to renew our leased office space in Woodland Hills, California for our corporate headquarters. The new lease is for a term of 10 years and has provisions for space reduction at specific times over the term of the lease, but it does not provide for complete cancellation rights. The total...

  • Page 141
    .... In 2006, we entered into a new three-year contract agreement with an external third party service provider for it to provide outsourcing services such as enrollment and member billing services as well as claims processing services for our Prescription Drug Plan and Private Fee for Service products...

  • Page 142
    ... These two lawsuits are styled as nationwide class actions and are pending in the United States District Court for the District of New Jersey on behalf of a class of subscribers in a number of our large and small employer group plans. The recent developments in the fourth quarter of 2006 include the...

  • Page 143
    HEALTH NET, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 2005 Charges On May 3, 2005, we and the representatives of approximately 900,000 physicians and state and other medical societies announced that we had signed an agreement (Class Action Settlement Agreement) settling the lead ...

  • Page 144
    ... benefit costs incurred in connection with the involuntary workforce reduction is as follows: Reportable Segments Total Health Plan Government Reportable Corporate Services Contracts Segments and Other (Dollars in millions) Total Balance as of January 1, 2004 ...Amount incurred during the year...

  • Page 145
    ... criteria Similar managed health care products and services including HMO, PPO and POS, Similar production process as they support similar customer groups and products, Same type of customers, individuals within large and small employer groups and senior and commercial individuals, Similar...

  • Page 146
    ....3 $ 99.2 Our health plan services premium revenue by line of business is as follows: Year Ended December 31, 2006 2005 2004 (Dollars in millions) Commercial premium revenue ...Medicare Risk premium revenue ...Medicaid premium revenue ...Total Health Plan Services premiums ...F-52 $ 6,903.5 2,304...

  • Page 147
    ...) Total reportable segment pretax income ...Debt refinancing charge ...Litigation, severance and related benefit costs and asset impairments ...Net gain on sale of businesses and properties ...Income from continuing operations before income taxes ...Note 16-Reserves for Claims and Other Settlements...

  • Page 148
    HEALTH NET, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) and medical cost trend. Claims liabilities are estimated under actuarial standards of practice and generally accepted accounting principles. The majority of the reserve balance held at each quarter-end is associated with the ...

  • Page 149
    ... our Medicare business. 2005 March 31 June 30 September 30 December 31 (Dollars in millions, except per share data) Total revenues ...Litigation, severance and related benefit costs ...Income (loss) from operations before income taxes ...Net income (loss) ...Basic earnings per share (1) ...Diluted...

  • Page 150
    ...FINANCIAL STATEMENTS-(Continued) Sale/Leaseback of Shelton, Connecticut Property On February 23, 2007, we entered into an agreement providing for a sale/leaseback of the company's 68-acre commercial campus in Shelton, Connecticut (the "Shelton Property"). Under the terms of the agreement, Health Net...

  • Page 151
    SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY) HEALTH NET, INC. CONDENSED STATEMENTS OF OPERATIONS (Amounts in thousands) Year Ended December 31, 2006 2005 2004 REVENUES: Net investment income ...Other income ...Administrative service agreements ...Total...

  • Page 152
    SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY) HEALTH NET, INC. CONDENSED BALANCE SHEETS (Amounts in thousands) December 31, 2006 December 31, 2005 ASSETS Current Assets: Cash and cash equivalents ...Other assets ...Deferred taxes ...Due from ...

  • Page 153
    SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY) HEALTH NET, INC. CONDENSED STATEMENTS OF CASH FLOWS (Amounts in thousands) Year Ended December 31, 2006 2005 2004 NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES ...CASH FLOWS FROM INVESTING ACTIVITIES: ...

  • Page 154
    SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY) HEALTH NET, INC. NOTE TO CONDENSED FINANCIAL STATEMENTS Note 1-Basis of Presentation Health Net, Inc.'s (HNT) investment in subsidiaries is stated at cost plus equity in undistributed earnings (losses) of ...

  • Page 155
    SUPPLEMENTAL SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS AND RESERVES HEALTH NET, INC. (Amounts in thousands) Balance at Beginning of Period Charged to Costs and Expenses Credited to Other Accounts (1) Balance at End of Period Deductions 2006: Allowance for doubtful accounts: Premiums receivable...

  • Page 156
    ...'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 (File No. 1-12718) and incorporated herein by reference). Employment Agreement between James Woys and Health Net, Inc. dated January 30, 2006 (filed as Exhibit 10.8 to the Company's Annual Report of Form 10-K for the year...

  • Page 157
    ...). Form of Restricted Stock Unit Award Agreement utilized for eligible employees of Health Net, Inc. (filed as Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the Commission on March 6, 2006 (File No. 1-12718) and incorporated herein by reference). Form of Performance Share Award...

  • Page 158
    ...). Amendment Number One to the Health Net, Inc. (formerly Foundation Health Systems, Inc.) Deferred Compensation Plan Trust Agreement between Health Net, Inc. and Union Bank of California, adopted January 1, 2001 (filed as Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year ended...

  • Page 159
    ...). Amendment Number Seven to the Health Net, Inc. 401(k) Savings Plan adopted December 27, 2006, a copy of which is filed herewith. Foundation Health Systems, Inc. Supplemental Executive Retirement Plan effective as of January 1, 1996 (filed as Exhibit 10.65 to the Company's Annual Report on Form 10...

  • Page 160
    ... Number One Through Three to the Amended and Restated Deferred Compensation Plan of Foundation Health Corporation (filed as Exhibit 10.49 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004 (File No. 1-12718) and incorporated herein by reference). Foundation Health...

  • Page 161
    ...herein by reference). Office Lease Agreement dated August 18, 2000 by and between Physicians Health Services of Connecticut, Inc. (predecessor to Health Net of Connecticut, Inc.) and Beard Sawmill, LLC (filed as Exhibit 10.68 to the Company's Annual Report on Form 10-K for the year ended December 31...

  • Page 162
    ... is filed herewith. * Management contract or compensatory plan or arrangement required to be filed (and/or incorporated by reference) as an exhibit to this Annual Report on Form 10-K pursuant to Item 15(c) of Form 10-K. †A copy of the exhibit is being filed with this Annual Report on Form 10...

  • Page 163
    ... Jay M. Gellert, certify that: 1. 2. I have reviewed this annual report on Form 10-K of Health Net, Inc.; Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances...

  • Page 164
    ...of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, James E. Woys, certify that: 1. 2. I have reviewed this annual report on Form 10-K of Health Net, Inc.; Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state...

  • Page 165
    ... the Annual Report of Health Net, Inc. (the "Company") on Form 10-K for the year ending December 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Jay M. Gellert, as Chief Executive Officer of the Company, and James E. Woys, as Interim Chief Financial...